The Federal Government's Review into the governance, efficiency, structure and operation of Australia's superannuation system (the Review) may result in some of the most significant reforms the superannuation industry has seen in recent years.
While the Review is not due to release its final report until 30 June 2010, industry participants would be well advised to start considering the possible ramifications of the Review on their business.
Terms of reference
The terms of reference for the Review are wide-reaching and focus on the following four issues in relation to superannuation:
(a) Governance, which represents phase one of the Review and covers matters such as:
(b) Efficiency, which represents phase two of the Review and covers matters such as:
(c) Operation, which represents phase two of the Review and covers matters such as:
(d) Structure, which represents phase three of the Review and covers matters such as:
As can be seen from the terms of reference for superannuation trustees, the Review's recommendations will impact on all aspects of their business. However, the impact of the Review is likely to be felt much more widely than superannuation trustees alone. For example, the relative benefits and costs of active investment management and passive investment management could be examined by the Review. While this may have implications for superannuation trustees and how they allocate their funds for investment, the implications for active investment managers will be far more significant.
The Review has already released its first Issues Paper in relation to the governance of Australia's superannuation system. A second Issues Paper will be released in relation to the operation and efficiency of Australia's superannuation system in mid October and a third Issues Paper in relation to the structure of the superannuation system will be released in mid December. The Review will receive submissions and make interim recommendations in relation to each Issues Paper prior to releasing its final report on 30 June 2010.
It is likely that certain fee arrangements will be subject to considerable scrutiny as part of the second Issues Paper focusing on the operation and efficiency of the superannuation system.
Any recommendations made by the Review in relation to fees will have a direct impact on the amount and structure of fees charged by not only superannuation trustees, but also investment managers, platform providers, product wholesalers and financial planners. Below is a brief summary of these fee arrangements together with an analysis of whom will be most affected:
(a) Percentage based investment management fees
Investment management fees are typically charged as a percentage of funds under management (FUM). This, of course, results in investment managers receiving higher fees as FUM increases. However, a likely area of focus for the Review is that percentage based investment management fees are potentially at odds with the increased economies of scale available to larger funds.
Any shift from percentage based investment management fees would be fundamental and it is difficult to predict what alternative form of remuneration for investment managers would emerge in its place. A less dramatic change would be for a greater onus to be placed on investment managers and superannuation trustees to reduce or rebate investment management fees to fund members as FUM grows.
Up front and trail commissions are typically paid to financial advisers for the provision of advice in relation to the investment of a member's superannuation contributions. Recently, the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen, suggested that more needs to be done to eliminate conflicts of interest and perceived conflicts of interest from payment models in the superannuation industry. The Review is, therefore, likely to focus on alternative remuneration arrangements for financial advisers which will reduce the potential conflict of interest presently faced by advisers who are remunerated on the basis of the amount invested in a product that the adviser recommends to their client.
One alternative that is likely to be considered closely as part of the Review will be a shift towards financial advisers charging fees on an hourly basis. However, as has been foreshadowed by ASIC in its submissions to the Parliamentary Joint Committee Inquiry into Financial Products and Services in Australia, there is also the potential for legislation to be introduced restricting, or even prohibiting, the use of certain fee arrangements.
The FPA and IFSA have also initiated their own reviews of financial adviser remuneration arrangements. However, it should be borne in mind that any recommendations made by the Review will ultimately have the force of law and could therefore override any reforms introduced by these industry bodies.
(c) Performance-based fees
While performance fees are a common feature of hedge funds, there has been an emerging practice of investment managers also being remunerated by superannuation trustees on the basis of performance. Given that superannuation is intended to be a long term investment for members, the Review is likely to focus on whether remuneration arrangements that reward investment managers for exceeding short-term performance benchmarks are appropriate.
(d) Shelf fees
Shelf fees are paid by investment managers to platform providers, master trusts and dealer groups for including their fund on an investment menu. Although these fees are paid for out of an investment manager's own resources, the Review is likely to focus on whether shelf fees are effectively cross-subsidised through other fees paid by superannuation members. Any shift away from the charging of shelf fees by platform providers may impact the availability of certain funds on such platforms.
(e) Buy/sell spreads
The Review is also likely to look at buy/sell spreads and, in particular, whether they are too high. Consequently, an outcome of the Review may be that greater emphasis is placed on ensuring that buy/sell spreads charged by trustees reflect the actual costs incurred by trustees in relation to the acquisition and realisation of underlying investments. Any recommendations made by the Review in relation to buy/sell spreads charged by trustees may also extend to buy/sell spreads charged by investment managers of the underlying funds in which trustees may invest.
(f) Insurance premiums
Most superannuation funds offer members group cover for life as well as disability insurance and it is common practice for commissions to be paid to advisers who recommend these forms of cover to members. The Review is likely to focus on these commissions, and in particular whether premiums are marked up to enable the payment of commissions to advisers. Any shift away from the payment of commissions to advisers for recommending life insurance products to members is likely to have a significant impact on the distribution of life insurance products in the future.
(g) Other fees
The Review will no doubt focus on a whole range of other fees that are currently charged to superannuation fund members. Contribution fees, exit fees, investment switching fees and various rebates are all likely to be examined, with the objective of ensuring that such fees are charged in a manner that will result in a greater alignment with the interests of members in the future.
While it is not possible to predict what the precise outcomes of the Review will be in relation to fees, it is at least clear that certain practices in relation to fee arrangements are likely to be the subject of considerable scrutiny throughout the Review.
In this regard, it is the view of the author that those fee arrangements that are simple, transparent and which demonstrate a clearly discernible link between the services provided and the fees charged, are less likely to be affected by the Review than those fee arrangements that are complex, ambiguously disclosed and which demonstrate little or no relationship between the service provided and the fee charged.
Furthermore, as can be seen from the brief overview set out above, any recommendations made by the Review could potentially have a significant impact on how fees are charged by not only superannuation trustees, but also investment managers and financial advisers, among others.
Accordingly, superannuation trustees and other industry participants would be well advised to consider the potential impact of the Review now when entering into any long-term contractual arrangements or making any commercial or strategic decision that is likely to have a material impact on their business.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.